Bank of England working paper examines sufficiency of macroprudential regulators

A Bank of England working paper examines how well equipped today’s macroprudential regulators are equipped to deal with a re-run of the factors that led to the global financial crisis. Authors David Aikman, Jonathan Bridges, Anil Kashyap, and Caspar Siegert discuss the ability of regulators to address vulnerabilities presented by the fragility of the financial sector and build-up in indebtedness in the household sector (Staff Working Paper No. 747).

U.S. and U.K. regulator comparison. The researchers compared and contrasted how well equipped two prominent macroprudential regulators—the U.S. Financial Stability Oversight Council (FSOC) and the U.K.’s Financial Policy Committee (FPC)—are to implement necessary policy actions. The two stand at opposite ends of the spectrum in a comparison of financial stability committees created since the crisis. The U.K.’s FPC, with its wide-ranging toolkit to achieve its mandate to protect and enhance the resilience of the U.K.’s financial system; and the FSOC, with few powers under its direct control, despite its mandate to identify and respond to emerging threats to financial stability.

Macroprudential intervention. Asking whether macroprudential policy have prevented the last crisis, the authors answer "perhaps." Despite the challenges in spotting and responding to build-ups of risk in real time, their analysis "suggests a macroprudential regime with a suitably strong mandate, coupled with powers to adjust financial system leverage and maturity/liquidity transformation and to limit household sector indebtedness, could have significantly ameliorated the macroeconomic fall-out from the collapse of the real estate bubble."

Existing framework. Turning to whether today’s macroprudential regimes are sufficiently well-equipped to do this, the paper argues that the "FSOC would likely make little difference were we to experience a re-run of the factors that caused the last crisis." On the other hand, the authors contend that a macroprudential regulator with the mandate and powers of the U.K.’s FPC "stands a better chance." However, an FPC-type regime would require political backing to regulate non-bank financial institutions, in their view.

Challenges ahead. The paper raises several questions for consideration:

How much faith should we have in a macroprudential regulator’s ability to identify problems and act in real-time? Given uncertainty, policy frameworks should be calibrated with some built-in "slack" to account for the fact that elevated risks may not always be obvious in real time.

How wide should the remit of a macroprudential regulator be? Because the resilience of lenders might not be sufficient to avoid costly crises without actions targeted at preventing build-ups in household debt, there is debate over structuring macroprudential frameworks. It is not clear whether such interventions should be left to technical committees or to democratically-elected governments.

Which specific powers does a macroprudential regulator require, and how actively should it be in using these? Warnings of a more powerful financial stability committee might be more targeted and informative than regulators lacking the tools to address risks.

How do societies ensure that macroprudential regulators have the power to take meaningful actions, but are also sufficiently accountable to sustain legitimacy in the long-run? Because the success of a macroprudential authority is hard to verify, granting additional powers to an independent macroprudential regulators comes with accountability challenges.